By Gillian Kemmerer | HedgeFund Intelligence
Brazil is approaching a recession, beleaguered with currency devaluation, inflation and political volatility. While many domestic investors look abroad to escape the chaos, some battle-tested managers and valueseekers are finding new reasons to venture south.
The financial world has long been fascinated with Brazil’s potential, but continuously finds itself disappointed when the “country of the future” misses targets and expectations. Absolute Return decided to revisit the country after its pivotal presidential election to perform a temperature check on the hedge fund industry. The following feature is the result of interviews conducted in Sao Paulo, Rio de Janeiro and New York with prominent managers, investors, prime brokers and administrators.
The addresses of Rio’s largest asset managers read like a set of postcards: Leblon, Copacabana, Ipanema. Modest skyscrapers rise a stone’s throw from the country’s famed white sand beaches, housing billiondollar brand names from JGP to Gávea. From the top floors, you can just make out the bronzed joggers who run between the rocks at Arpoador and the beachfront Copacabana Palace, a luxury resort famed for its riviera architecture and roster of scandalous guests, including author Orson Welles who once threw a piano into the hotel’s starstudded pool.
The hedge fund landscapeBrazil’s distinct breed of hedge fund is called the multimercado, or multimarket fund. For years, multimercados followed a formula called the “Brazil kit,” which described a portfolio primarily allocated to government bonds, with a smattering of other investments including currencies, stocks and interest rates. Brazil has a long history of inflation woes and large debttoGDP ratios, leading the Central Bank to maintain a high SELIC and therefore generating attractive yields for bond holders. A relative period of economic stability in 20102011 brought the rate down to single digits, and asset managers diversified their holdings as a result. According to Sao Paulobased data provider Economatica, fixed income has resurged in recent months, though its “trough” has not dipped below 74% of total fund industry allocation since 2010. As of May, fixed income represented more than 80% of allocations in Brazil — hardly a surprise as government bonds yield over 14% — and equity exposure has continued its downward trend since 2011, comprising approximately 6% of all fund portfolios. While many managers now hold quantities of other instruments such as global currencies, the CDI (the average overnight rate for interbank loans, which tracks the SELIC) remains the performance benchmark for Brazilian asset managers, many of whom make their performance fees based on their profit above the interest rate. “It’s very hard to build an investable benchmark for hedge funds, especially equity hedge funds,” Adilson Ferrarezi, head of HSBC’s Latin American fund of funds unit, told Absolute Return. “The Brazilian market is small, managers’ investment approaches and styles change over time, survivorship bias removes underperformers from the industry, and the strategy capacity is limited such that topperformers close to new client subscriptions. Equity hedge funds are structured as multimarket funds, which is an asset class that historically competes with traditional fixed income. In this case, the opportunity cost to invest in a multimarket fund is the CDI.” In an attempt to mitigate the survivorship bias of the Brazilian fund industry, the Absolute Return Brazil Index (graph below) was constructed to include funds that shuttered within the period of 2009 to 2015. Even with this inclusion, the index consistently outperforms the Absolute Return Composite Index of all funds in the database. The BOVESPA outperforms both indices until 2013, and has since lagged both U.S. and Brazilbased hedge funds. “The talent in the Brazilian hedge fund industry is incredible,” said the founder of a major third party marketing firm based in Rio de Janeiro, who asked to remain anonymous. “The precrisis winners — Fraga [Gávea], Jakurski [JGP], Stuhlberger [Verde] — are battle hardened, have survived decades of Brazilian economic downturns. But still, investors are scared.”
“While demand for longbiased Brazilian equity strategies has been challenged, we have seen an increased interest in distressed strategies such as nonperforming loans and private equity,” said David Frank, chief executive of thirdparty marketing firm Stonehaven. Several firms including Blackstone’s asset manager Pátria Investimentos and Gávea secured over $1 billion late last year for private equity funds that invest in Brazilian companies.
The grass is always greenerAmong domestic investors, the appetite for farflung shores is growing, cast against a backdrop of a highly correlated and sluggish stock market, as well as the country’s volatile currency, the Real (BRL). The avenues to invest abroad are widening in thanks to new regulations, and some Brazilbased managers are taking note of the increased appetite for geographic diversification. Still, the industry remains far more insular than its European and American competitors; according to Economatica data, only 1.82% of all assets in the Brazilian fund industry are allocated abroad (see graph). Sat in the Rio de Janeiro offices of asset management firm Vinci Partners — a bright and spacious headquarters awash in flamboyant, surrealist art — Bruno Cordeiro is one industry veteran responding to the call. The former head of commodities proprietary trading at investment bank BTG Pactual, Cordeiro launched global macro shop Ciclo Capital last year, securing seed capital from Vinci and another, unnamed investor. “The majority of Brazilian hedge funds are focused on local markets,” Cordeiro told Absolute Return. “We believe that there is a growing demand among Brazilian investors to have access to funds with different risk profiles. Strava [the flagship fund] is truly a liquid global macro and commodities fund.” Stonehaven’s Frank echoed the sentiments. “We’ve seen increased interest from Brazilian investors to diversify further in terms of currency, geography and alternative strategies,” he said. October regulatory changes will make it easier for both domestic managers to invest offshore, and qualified investors to allocate more of their wealth to overseas investments. Previous restrictions named any fund with over 20% offshore exposure as a “super qualified vehicle,” setting a minimum investment of $1 million BRL. “According to the new legislation, if a client’s wealth is larger than $15 million, this investor will be able to invest in any type of fund with 100% exposure abroad, and the minimum initial investment amount will be freely defined by the fund manager,” said Adilson Ferrarezi, head of the HSBC Multimanager Offshore Fund. Ferrarezi further elucidates the changing regulatory landscape here.
While some domestic investors are setting sail for other destinations, Christian Rogers, head of sales for Brazil Prime Services at Credit Suisse in São Paulo, sees renewed interest among foreign managers for lowerpriced Brazilian securities. Rogers notes that the high rate, weak currency environment has attracted global macro managers seeking better buys. “Foreign investment in interest rate futures, known as Interbank Deposits, or ID, has climbed to about 35%, up from 21.6% in 2013,” he told Absolute Return. (For more on the increased appetite for Brazilian securities, read Rogers’ full editorial).
According to Mark Yusko, chief investment officer of $4 billion fund of hedge funds Morgan Creek Capital Management, the Brazilian stock market is becoming a fertile ground for value investors. “If we look at Brazil, there are a lot of really cheap assets,” Yusko said in a BRICfocused presentation on July 30. He pointed specifically to steelmaker Companhia Siderúrgica Nacional, mining giant Vale, and airline Gol Transportes Aéreos, all of which have weathered doubledigit declines in the past year.
“These are good companies. These companies are not going away. We think there has been a lot of bath water thrown out, and we think there’s a few babies in there.” Yusko noted that Morgan Creek had not made any purchases in Brazil yet, but believes “there will be some really good opportunities to make money” as prices continue to deteriorate.
Back to the future
Viennese author Stefan Zweig moved to the Brazilian “imperial city” of Petrópolis in 1941, impressed with the sheer expanse and racial tolerance of Brazil at a time when Europe was torn apart by war. Before taking his own life, Zweig authored a book entitled, “Country of the Future,” praising his adopted home and unintentionally inspiring a common joke that continues to deride it.
“Brazil is the country of the future — and always will be,” the exhausted refrain goes, and as the domestic economy prepares for yet another period of recession and austerity, it appears to ring true.
But as many investors have learned throughout the world’s emerging economies, sometimes the transition period is more lucrative than the destination. “Changing environments often provide opportunities,” Credit Suisse’s Rogers wrote, “and the winds have certainly changed in Brazil.”
While it remains to be seen whether or not Levy will be successful in turning Brazil into the BRIC it was once heralded to be, it appears that opportunities exist for intrepid investors who do not plan to wait for the elusive Brazilian future.